Antonia, 27, wants to retire in 15 years. She’s trying to figure out whether to contribute to pre-tax or after-tax retirement accounts.
Most financial advice for 20-somethings that she’s encountered says to contribute to after-tax (Roth) retirement accounts. These articles assume that a 27-year-old will continue earning money for the next 30+ years, presumably escalating into higher tax brackets along the way.
By paying taxes upfront, these articles say, you’ll enjoy 30+ years of compounding gains, which you’ll be able to withdraw tax-exempt.
But what if, like Antonia, you’re only 15 years from retirement? Should you stick with Roth tax treatment? Or is there wisdom in making retirement contributions with pre-tax money?
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Marisa is young, high-income, and highly risk-tolerant. She’d like to know: what asset allocation would I suggest for a young, risk-tolerant person? And is rebalancing her portfolio necessary, or just a distraction?
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Dylan owns his home outright. When he sells it, he’ll collect about $100,000 after fees. He also has an additional $100,000 saved in cash.
He’d like to buy a home free-and-clear. What’s the best way to approach this? Should he take out a home equity line of credit? A bridge loan? Something else?
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Pal lives in the San Francisco Bay Area. He recently bought his first rental property, and he’s interested in building passive income and reach financial independence.
He’s curious about credit card piggybacking, a side hustle by which a person with a high credit score adds another person with a low credit score as an authorized user to their card.
It seems like a legitimate way to earn extra money. Why aren’t more people talking about this? Is there a problem he’s overlooking?
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Anonymous, 24, says she knows next-to-nothing about investing. She has $6,500 in her Roth IRA, invested in a Washington Mutual Class A mutual fund, which is an actively-managed mutual fund with a front load.
Should she keep her money there? Or should she move it?
Her second question is about her 401k. She contributes 5 percent of her paycheck into a Roth 401k account, from which she invests in a Target Date retirement fund. Her employer doesn’t match any contributions.
Her total contributions to both accounts (her Roth 401k and Roth IRA) equal $5,500 per year.
Should she stop contributing to her Roth 401k, so that she can focus her contributions on her Roth IRA?
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Jeff and his wife are both 64. When he reads about retirement, the information is ambiguous about Social Security.
Let’s say that he has $1 million saved towards retirement, which generates $40,000 annually at the 4 percent rule of thumb. Let’s also say that he is eligible for Social Security income of $40,000 per year. Doesn’t this mean he could retire on $80,000 per year? If so, then why do “4 percent rule” projections only talk about the portfolio portion?
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Former financial advisor Joe Saul-Sehy and I discuss these questions on today’s episode. Enjoy!
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Are you considering early retirement and looking for ways to maximize your retirement savings? One of the key decisions you’ll need to make is whether to invest in a Roth or Traditional IRA and 401(k). In this article, we’ll break down the differences between these retirement accounts and discuss how they can impact your early retirement plans.
Traditional IRA and 401(k)
A traditional IRA and 401(k) are both tax-deferred retirement accounts. This means that contributions are made with pre-tax dollars, reducing your taxable income in the year in which you make the contribution. Additionally, the investment growth in these accounts is tax-deferred, meaning you won’t pay taxes on the gains until you start making withdrawals in retirement.
One of the main benefits of a traditional IRA and 401(k) is that it allows you to defer taxes and potentially reduce your current tax burden. This can be especially advantageous if you expect to be in a lower tax bracket during retirement. Additionally, many employers offer a matching contribution for 401(k) contributions, which can significantly boost your retirement savings.
Roth IRA and 401(k)
On the other hand, a Roth IRA and 401(k) are funded with after-tax dollars, meaning you won’t receive a tax deduction for your contributions. However, the main advantage of Roth accounts is that withdrawals made in retirement are tax-free. This can be particularly beneficial for early retirees, as it allows you to access your retirement savings without having to worry about tax implications.
Another advantage of Roth accounts is that they are not subject to required minimum distributions (RMDs) after age 70 ½, unlike traditional retirement accounts. This means that you can continue to let your investments grow tax-free for as long as you like, providing more flexibility in managing your retirement income.
Choosing the Right Option for Early Retirement
When deciding between a Roth and Traditional IRA and 401(k) for early retirement, there are several factors to consider. If you expect to be in a higher tax bracket during retirement, a Roth account may be more advantageous as it allows you to lock in your current tax rate. On the other hand, if you anticipate being in a lower tax bracket, a traditional account may provide more tax savings in the long run.
It’s also worth considering your timeline for early retirement. If you plan to retire before age 59 ½, you may face penalties for early withdrawals from a traditional retirement account, whereas Roth accounts allow more flexibility for accessing your savings before this age.
Ultimately, the best approach for early retirement may involve a combination of both Roth and traditional accounts. By diversifying your retirement savings across different tax treatments, you can create a tax-efficient income stream that meets your needs in retirement.
Conclusion
Choosing the right retirement accounts for early retirement is an important decision that can impact your long-term financial security. Both Roth and traditional accounts have their own advantages and drawbacks, and the best approach will depend on your individual circumstances and financial goals. If you’re unsure which option is best for you, consider consulting with a financial advisor who can help you develop a retirement savings strategy that aligns with your early retirement plans.
@Afford Anything: your guest is off on acceptance of an ER 0.58% — it’s simply imprudent to consider/stay with such a fund when the index fund/ETF ER 0.03% is available and oh so easy to transact a swap — @Joe Saul-Sahy, you may benefit from some perspective: 1) fees are not insignificant to a decades long investment program, and 2) fees are almost trivial to minimize — your dismissal of that cost-benefit alternative is borderline arrogant (you may not wish to allow your deep experience working with clients cloud your own self-assessment of the counseling you give here)
After tax traditional 401k isn't that bad. It isn't subject to the 19k limit and you can convert it to Roth, aka the mega backdoor Roth.
Terrible job understanding/explaining the benefit of the after tax 401(k) contributions. There is a time and a place for it and if you don’t know when that is, it’s time to stop teaching and go back to school.
The guy sucks. Paula is great.
or you can just buy vanguard ETFs
A lot of people were not born intelligent, and therefore did not receive a multi million dollar trust fund. Many of the successful people in society are the offspring of criminals.
This guy makes one bad suggestion after another. Scary advice.
I have to disagree with Joe around 5:00. I max out the regular contributions I'm allowed ($18,500) with deductible traditional 401(k), and then I choose the after-tax non-deductible traditional option to contribute beyond that, because the contribution limits are higher for that. Yes, it has very few of the typical advantages, but I can then roll it over relatively quickly to Roth. See https://www.madfientist.com/after-tax-contributions/ for an explanation of how that works.
My particular company plan makes this particularly easy. I imagine the paperwork can get a lot more complicated and not worth it, but Rothing an extra several thousand dollars per year may still be worth it. You should max out the regular $18,500 first, though.
.58% expense ratio compounded over a few decades will be a ridiculous % of earnings lost to fees!
Paula – Noticed you have become sensitized to split FI and RE. Please do not. Susie posted an article in Likenden misrepresenting or justifying her view of FIRE.
We been following the FIRE community for about 8 years. It helped us realized and learned a lot of things we needed to do. No need to apologize.
The risks Susie highlighted are less than likely or extreme. Please do not let fear and doubt drive your emotions. Live in faith and believe of righteousness. These risks do have rational and reasonable mitigations. A zero risk life is eutopia and falls in the area of 100% solution versus 80%, 90%, or 95%. Here is a link to a guy making the counter point to Susie, Ramsey, and Market Watch.
https://youtu.be/wSQRHFhKBnE
Back to this podcast. One of our biggest challenges is the traditional to Roth conversion. We have two large 401Ks and are happy with their performances.
Conversion to a Roth IRA is a must but can't find the equivalents funds to convert that map to the 401K funds. Our 401K directors do a great job making sure the funds available are top notch. Sounds trivial but is not. We also are conscious of taxes so we are trying to time the conversion and find the equivalent funds in convention brokage houses.
Another point, growth on a traditional 401K or IRA in our experience out performs the Roth. There was a superb article by Mad Fientist on this. A benchmark. Our return needed on investment is only 6% so a fairly balanced portfolio in our 401Ks do it.
Thanks again and we enjoy your podcasts.
Alberto & Ann Ortiz,